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August 29, 2013

Obamacare Tax Stumps Advisors

Advisors have no choice but to start talking with clients about the investment tax and to try to estimate its potential impact

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The investment tax included in the bill caused angst when announced, with many advisors predicting a European-style transaction tax as the next logical step. Now it’s causing confusion, as those same advisors have no idea how to provide clients with reduction strategies. But other advisors say that if you're not ready to deal with the tax, you haven't been paying attention.

The problem, according to The Wall Street Journal on Wednesday, is too little (or no) guidance, something the IRS has promised, but as of yet is only “reviewing all comments and will take them into account as it develops final regulations.”

“In the meantime, advisors have no choice but to start talking with clients about the tax — which targets dividends, capital gains and other investment — and to try to help estimate the best they can its potential impact for 2013,” the paper says.

As a hypothetical, the paper describes a family that owns a business that manufactures aircraft parts, which is held in five trusts. One son is the trustee of all of the trusts, as well as an owner and an employee.

An advisor might recommend that the man keep separate logs that document time spent wearing each hat in the business. His reason: the IRS may end up applying the tax based on how active the taxpayer is in helping to run the business.

“In fact, that is the way the IRS imposes the 3.8% tax on businesses set up as S corporations or partnerships. Someone who owns a business in his own name, not a trust, doesn't owe the tax if he can show he worked a certain number of hours on the job, is its sole participant, or meets other criteria.”

The Journal concludes that the stakes are high. Individuals don't have to pay the 3.8% tax unless they have an adjusted gross income of $200,000 or higher ($250,000 if married and filing jointly). But trusts must pay it on undistributed income above $11,950.

“No guidance on the tax? I wrote about planning for 3.8% Medicare Tax 3 YEARS ago. Kitces Report newsletter, April 2010!” Michael Kitces, director of research with Pinnacle Advisory Group, tweeted upon publication of the story.

When it was noted there is no official guidance, Kitces countered, “There's been OFFICIAL guidance too. Treasury's binding proposed Regulations were issued last year,” before tempering his comments with, “They were proposed regs, not temporary. Means IRS isn't bound by them.

"Nonetheless, scenarios that are "gray" are highly esoteric & rare. Had ZERO problem applying rules to any client."

“Many in addition to @MichaelKitces educate advisors on ACA tax rules," added financial advisor and physician Carolyn McClanahan, who proudly notes she’s read all 2,409 pages of health care reform law. "The only advisors who are stumped must not be doing CE.”